A group of stocks that led the past two market rebounds is lagging this time around. And that may be a bearish signal.
Small caps — stocks with a market capitalization of less than $2 billion — originally kept pace with S&P 500 in a rally back from December lows. Markets had been hammered in the fourth quarter, but both indexes have regained more than 16 percent since late December.
But in the past two months, the Russell 2000 has been much weaker. The index of small-cap stocks is down by roughly 1 percent since late February. The S&P 500 is up more than 4 percent in the same time period.
Ned Davis Research warned of the trend out in a note to clients this week. The firm has small-caps “on watch” for a downgrade from neutral to bearish. Ed Clissold, chief U.S. strategist at Ned David Research, is still looking for confirmation that small-caps are warning of a broad market peak.
“The small-cap weakness has become a favorite point of emphasis of the bears, and not without reason,” Clissold said. “The small-cap warning is backed by rationale.”
For chart analysts, weak small cap shares mean the market has poor so-called breadth.
For other investors, it has macroeconomic implications. These smaller companies are generally more vulnerable to economic cycles. They tend to hold more debt than their large-cap peers, making them especially sensitive to things like rising interest rates and wage inflation.
“From a macroeconomic view, small-caps tend to be more economically sensitive, so under-performance can be a recession warning,” Clissold said.
One reason small caps usually lead rallies is that they tend to be less liquid. So when the stock market rises, they may get bid up more quickly, according to Dan Miller, director of equities at GW&K Investment Management.